The theme of this presentation is that alcohol is no ordinary commodity; economic policy has to think about it differently.

The alcoholic beverages industry, of course, produces jobs and profits for investors, just like any other industry. And just like them, if purchases of its product fall off there are fewer jobs and lower profits in the industry. But, of course, consumer would switch their purchases to other industries and there would be an offsetting expansion of jobs and profits there. There is nothing special about the production side of the alcoholic beverages industry, although we should observe that it is increasingly monopolised by a few suppliers – but again that is true for many other products.

Why Alcohol Is No Ordinary Commodity

Three things make alcohol unusual. The brief economic expression for the one is ‘externalities’, for the second it is ‘time-inconsistent decision-making’, and the third is ‘learning’.

Externalities

The payment for most commodities covers the social costs of the consumption, in particular the fact that the resources used in making the product could have been used for some other purposes. When a person purchases a product they are making a judgement that its consumption is worth more to them than it is to the rest of society, as signalled by the price embodied in the product. Economists say that these social costs are ‘internalised’ in the decision-making.

The consumption of alcohol is distinctive because sometimes – perhaps often – there are significant social costs which are not included in the price the purchaser pays (unless there is an excise duty which I will explain about shortly) and are likely to be ignored in the individual’s decision-making. The list of these ‘externalities’ – social costs which are not internalised – is long: direct harm to others including violence to innocent people, damage to property including car crashes, and health and social service costs from alcohol misuse which the alcohol user cannot or does not pay. A range of studies in many countries show that the external costs of alcohol consumption (i.e. those not incorporated in the private price of alcohol) are very large.

The most efficient way to deal with externalities is to internalise them and include them in the price of the purchase, which can be the effect of excise duties on alcohol. Unfortunately the unit cost of the externalities varies with the numbers of drinks and may also be influenced by who, where and when. There is no practical excise duty which can efficiently and fairly deal with all the externalities.

The best strategy seems to be, as far as possible, to deal directly with the source of externality, including, if necessary, using prohibition. For instance, many societies have increasingly clamped down on drink-driving. Another common action is to prohibit purchase by particular age groups or by time or place.

Typically these measures are clumsy – like excise duty, I suppose – but insofar as they are effective, they reduce the required level of excise duty. I shall have more to say about excise duty

issues below.

Time-inconsistent Decision-making

Implicit in the previous discussion was the assumption that consumers make rational decisions in which the benefits to themselves from their consumption are offset against its social costs.

It is a fundamental tenet of liberal societies that individuals know what is best for them. In only a few highly select instances do such societies assume otherwise – children and the senile are examples. The liberal society treats the individual as a mature adult able to make the best decision for themselves – or at least to make a better decision than anyone else; it therefore does not generally say you are wrong to drink alcohol (or to drink too much alcohol) providing you pay the full social cost.

However, behavioural economics has convincing research evidence that individual decision-making is more complex than pure rationality, and that sometimes people make decisions which later they regret. I’ll avoid the details here, but a good example is the person who goes into a bar planning to have a couple of drinks, abandons the plan and drinks half a dozen, and the following morning regrets that they did so, as they knew they would before entering the bar. This is called ‘time-inconsistent decision-making’, in that the individual decisions are not consistent with rational decisions through time.

Sometimes there are strategies available to an individual to deal with time -inconsistent decision-making, as when a recovering gambling addict arranges for a casino to exclude them in case, in the heat of the moment, they try to restart their addiction. Similarly most successful recovering alcoholics refuse all alcoholic drinks.

Economists are struggling with the policy implications of this finding; how to – in the jargon – engineer the ‘architecture of choice’ in the context of ‘libertarian paternalism’. One conclusion which may be relevant to alcohol policy, is that taxes on alcohol (above those necessary to internalise externalities) may reduce the size of the regret. In terms of my illustration you have drunk less after going into the bar because the price was higher, and the next morning you are pleased you did.

Another example might be smaller packages so that you can purchase a 600ml bottle of wine and not be tempted to drink the last 150mls.

Learning

One has to learn to drink properly. It is normal to expect the young to learn how to engage in many adult activities; that is one of the functions of the education system. However there are some things to be learned for which school teaching is impractical, perhaps because the relevant age is after school. Sometimes the learner is in danger until the mastery is obtained. How do we provide a safe learning environment?

Since a car can be lethal weapon, the young typically learns to drive under supervision, and in stages. Even after obtaining a licence there may be restrictions on the driving for a time.

Learning to drink safely is a far more complicated exercise that learning to drive, but we are more casual about how individuals acquire their skills – which no doubt is why many people are worse drinkers that they are drivers, and why the drinking behaviour of too many parents is such poor example to their children. This not to argue we should require a license to drink, but it suggests we should have a public strategy with the objective of teaching the young how to drink safely. Developing one is not in an economists’ skill-set, but no doubt it includes some restrictions of access by the young, which are phased out as the young learn to drink safely.

Policy Responses

I have already mentioned that it makes sense to address the externalities by internalising them – like drunk-driving laws. Economists don’t have much expertise in this area.

I’ve also pointed out that because all externalities cannot be adequately addressed in this direct way, there is a strong case for levying a specific tax on alcohol. Much of the remainder of this paper will elaborate this approach but before doing so something needs to be said about restricting supply.

Every country has unique institutional arrangements so it is hard to be too specific about what each should do. Many have licensing laws which restrict who may sell, when they may sell, and to whom they may sell, together with other limitations as well.

To give an example: in my own country, New Zealand, we seem to be having a growing problem of the off-licence drinking of alcohol, particularly among the young. That does not mean we have solved all the on-licence problem drinking, but the host-responsibility strategy and making providers more responsible for drunkenness has had some success.

Among the measures taken or being considered to deal with off-licence drinking problems has been raising the age of purchase (which may not, of course, affect the age of consumption much). Particular consideration is being given to a lower age of on-licence purchase, which is under supervision, than off-licence purchase. There are also increasing restrictions on drinking in public places. We are also fiddling around with restricting sales outlets, and so on. I am not saying that New Zealand has the solution, but these are illustrative of the sorts of things which may be done. The justification for each of these policies is that alcohol is no ordinary commodity; there are aspects of all the three reasons – externalities, time-inconsistent decision-making, and learning – underpinning the interventions.

One problem New Zealand has not hit yet, but Britain has, is that some of its off-licence supermarkets appear to use liquor as a loss-leader to attract business making the offsetting profits from their sales of other commodities. While economists tend to frown on loss-leaders as anti-competitive, that alcohol is no ordinary commodity gives an additional reason for prohibiting the practice in its case. The liquor seller is privileged to be licensed, and may as a result have extra impositions on them. I shall be talking about minimum price strategies shortly.

Taxation

Historically alcohol has been the subject of special taxation because it was relatively easily to impose and a significant generator of revenue. Often the taxation was designed to impact more heavily on the rich than the poor, by higher rates on their drinks of choice. There was also an element of moral disapproval of drinking in the justification of the so-called sin tax.

In recent years there has been a greater focus on an economic rationale for a specific tax on alcohol. The usual case is based on the externality argument – the internalisation of the social costs which are not included in the private cost of the alcohol.

It might seem that the aim should be that the revenue from the specific tax should cover the social costs – the entire social costs including those which impact on the private sector such as domestic violence, as well as those which impact on the public sector, such as extra expenditure by the public health system. However economic theory focuses on the margin, and so the relevant social cost is that generated by the last drink in a session. Since, unlike in the case of tobacco whose social cost is much the same for each cigarette, the social cost rises with each drink in a session, the marginal social cost is greater than the average social cost, so the total revenue from the specific tax should exceed the total social costs.

Additionally, there may be a case for an additional levy – and hence greater revenue – to reduce time-inconsistent decision-making.

How should the alcohol be levied? The optimal levy would correspond as closely as possible to the incidence of social costs. There is little evidence that absolute alcohol from different types of drinks have different social costs. Until there is, the economic advice would be that as far as possible to levy the tax in proportion to the absolute alcohol content.

This would mean that the taxation content in the price of cheap alcohol would be a higher proportion than in expensive alcohol. I shall have more to say about this shortly, but here I need to say something about the argument that it is a regressive tax because the poor pay proportionally more. True, but that is not a case against levying according to absolute alcohol content. Giving the poor any tax break on alcohol is equivalent to subsidising domestic violence on the poor’s families. Better to recycle the extra revenue that a uniform levy will bring in to

the poor in terms of lower taxes on lower incomes, higher benefits and social assistance or subsidised nutrition, education and health services.

Given the convenience of taxing alcohol there is a temptation to impose additional taxes on higher valued alcohol – say by a sale tax. Whatever the merits of taxing luxuries, such taxes are not really part of alcohol policy, and the revenue should not be included when calculating the contribution to social costs.

(As an aside, I am amazed that the international alcohol lobby has not paid more attention to the duty free exemption on alcoholic products for travellers. It is hard to find a justification for it. This is an international issue and cannot be tackled at the national level, so it is an ideal matter to be raised at a forum such as this. For those who are concerned that government revenue would increase, perhaps the additional funds could be used for eliminating departure taxes.)

Whatever the counsel of perfection, most countries – including my own – are some distance from implementing it. Moreover, the issue of the minimum price of alcohol suggests a useful modification.

The Minimum Price of Alcohol

That individuals purchase absolute alcohol at a variety of prices indicates they are purchasing other characteristics such as taste, quality and consumption venue. Since none of these have as much impact on externalities, this reinforces the case for paying greater attention to absolute alcohol.

A further step has been to argue that a key economic policy variable is the minimum price of alcohol; that, in effect, for public policy purposes the focus should be on drinkers as if they are purchasing only absolute alcohol.

If people act in this way a rise in excise duty on alcohol may have little impact. Suppose someone purchases a ten dollar bottle of wine and an extra dollar is imposed on all bottles. Then they can buy what was previously a nine-dollar bottle, and get the same amount of absolute alcohol for their ten dollars. The only group who cannot do this trading down in the face of a tax rise is those who are already paying the minimum price for their absolute alcohol. Since that group includes alcoholics and heavy drinkers targeting the minimum price makes policy sense.

The next step is not so clear. We have already suggested that commercial and licensing law can be used for excessive price discounting. I shall come back to tax policy in a minute. A curious proposal is to regulate a set minimum price, which would mean that the proceeds from the higher price would go to the production and distribution industry – I doubt that the advocates of the policy think that would be a good thing.

Of course the excise duty could be raised further pushing up the minimum price of absolute alcohol, and also the price of all other drinks although not in proportion and – what may not be an unimportant consideration – the price of off-licence purchasers relative to on-licence purchases. (Minimum price strategies are likely to have more effect on off-licence drinking than on-licence drinking.)

(A variation on the minimum price strategy is to tax different sorts of alcohol at different rates. The excise duty on spirits in New Zealand is higher; perhaps the justification is that production costs of spirits are lower than for beer or wine, and the higher rate brings the selling price of absolute alcohol from spirits more in line with the other alcohol forms.)

Attractive as is the option of higher levies on alcohol to the alcohol lobby (and those trying to balance the government’s books), its difficulty is that there would be much resistance from those who are moderate drinkers and already paying for more than absolute alcohol. In some jurisdictions their political strength is sufficient to block such an increase.

There is another option which may be politically more attractive, in which there is a special tax on the cheapest drink, but it phases out (or ‘draws back’) as the prices of the drink rises. Thus it would hike the minimum price for purchasing absolute alcohol but have little impact on moderate drinking in which absolute alcohol was but one dimension of the total consumption decision and its price was higher.

What is being implicitly argued is that low price absolute alcohol is associated with much higher externalities than high price alcohol. That seems a reasonable proposition, although the systematic empirical evidence has not yet been brought together to validate it.

A major issue is whether the special tax with a drawback is administratively practical and not subject to avoidance. I think that it would be possible to design a reasonably effective regime in New Zealand – and probably in other countries with sophisticated distribution systems – but it may not be easy.

In summary there is a strong case for paying attention to the minimum price of absolute alcohol – collecting data would be a first step – and, one way or another, raising it without adding to the profits of suppliers.

Conclusion

While the analysis of why alcohol is not an ordinary commodity applies to all countries, perhaps with some minor for culturally specific situations, the policy responses set out here assume that the production and distribution system is of a modern sophisticated economy. Many developing economies still have much of the supply and consumption in the informal economy, which require different measures since those involving licensing and other supply restrictions and taxation cannot be as easily imposed.

However in many economies the informal alcohol supply industry is being replaced by (often international) corporations who will introduce and extend the structures which enable the policies proposed here to be implemented. There is usually apprehension about this change since the liquor corporations aggressively market their products and stubbornly resist the imposition of policies which effect safer and more socially acceptable drinking. The irony should not escape those who seek them for the most effective policies require the structures that the corporations create.